Private Student Loans- The Dangers

Private student loans can have substantially higher interest rates than government backed student loans. In addition, private student loans do not have the same protections available with federally backed student loans, such as rights to deferment or forbearance.

Unfortunately many young people who are preparing to go to college look at financing their education through rose tinted glasses. They think that if they

complete the education they are seeking they will simply get a high paying job and pay off their student loans and everything will work out just fine.

That is not always the case. I recently read the story of a young woman who had an exciting job in television journalism, but she was swamped by her student loans. She had 4 student loans including 3 private student loans and only one federally backed loan. She decided to attend a private college in New York, and she ended up borrowing $115,000 to finance her education. Her monthly loan payments were about $1200 per month, and although she had a good job, there is no way her salary could support that kind of debt. She attempted to obtain a private student loan consolidation, but the lender was not making any consolidation loans because of the credit crunch. So for the time being she is stuck and just has to try and struggle through her financial problems. It appears she also had an option to pay only interest on the loans for several years, but those payments would have been over $500 per month, and she would be making zero headway in paying off the principle on her loans. At least she has a decent job, and if she ever loses that she will be in really deep trouble.

The first mistake she made is one that many young people make. She borrowed much more money than she should have. If student loan borrowers would only heed the following advice, millions would be saved the agony that goes with eventual student loan default. Here is the advice: do not borrow more money than what your expected starting salary will be. If this young lady had only federal loans she would have had the right to consolidate them, but with private student loans she is simply at the mercy of the lender. She might be able to obtain a deferment, but she needs to be careful because she may find that after the deferment her interest rate is substantially higher. I recently read about a case where a private student loan with an interest rate of 13% jumped to 18% after a six month deferment, much to the surprise of the borrower. People need to be extremely careful and make sure they understand what it is they are signing up for. Have a parent, close friend or trusted relative go over the documents with you. If you end up carrying loans at 18% interest rate, like the borrower mentioned above, you are in deep trouble. And there is no way to extricate yourself from this trouble since private student loans, like federally backed student loans, cannot be dismissed in bankruptcy.

A student borrower also needs to realize that his loan payback needs to be about 10% of gross pay. If it is much beyond that the borrower is overextended and will probably find himself in serious financial trouble.

Some student borrowers are attracted to private student loans because of the relative ease of signing up for the loans, as opposed to the difficult and sometimes perplexing FAFSA form that must be filled out for federal loans. It is worth the trouble to get through the FAFSA form process, however, because federal student loans will always be substantially better for the borrower than private student loans. Be very wary of the latter. As stated above, don’t borrow more than your expected starting salary, and be careful your monthly payments won’t exceed 10% of your gross salary. And above all do everything possible to avoid defaulting on either federal and private student loans.